Conagra Brands: Value-Priced Dividend Play (NYSE:CAG)

Written by Nick Ackerman.

Conagra Brands, Inc. (NYSE:CAG) recently posted its latest quarterly results for Q2 of fiscal year 2024. The company lives in the future, with a fiscal year-end at the end of May. The results were mixed compared to analysts’ expectations, with revenue coming in a bit shy of the target. However, the miss was, as some would call it, a “rounding error,” as it was a miss of $20 million on revenue of over $3.2 billion.

That said, the company had also lowered its guidance on the back of weaker results across nearly the entire board. Volume recovery is taking longer than anticipated, and that is having a negative impact, but there is some optimism there as the pace of decline is more muted.

Net sales were down 3.2% year-over-year, and the new guidance for FY 2024 is to decline 1 to 2%. That’s down from the expectations for organic growth of around 1%. Additionally, operating margins were shaved to ~15.6%, a decline from the 16 to 16.5% previous guidance. Additionally, adjusted earnings are now targeted for $2.60 to $2.65; that was down from the $2.70 to $2.75 range.

Clearly, that’s not something we want to see as shareholders. Every company wants to beat analyst expectations and even boost guidance if they can. However, given the latest quarter, it would seem expected, and if they hadn’t lower guidance, that would have been more suspicious.

However, CAG is not priced to perfection and is very much a value-oriented company in the slow-growth consumer packaged foods business. That resulted in a fairly muted reaction in terms of the price of the company’s shares.

Additionally, it remains a solid dividend play with plenty of earnings and free cash flow to have conservative payout ratios. It leaves plenty of room to continue to pay down leverage, as that is one of their goals, which they continue to work toward their target of 3x by FY 2026.

Valuation, Earnings Recap And Outlook

The company trades well below its historical fair value range at only an 11x forward P/E ratio. Historically, the company had been able to trade in the 13.6x to nearly 17x range.

The measurement here is taking the low end of their forward earnings estimate of $2.60. So, there could be some wiggle room for further potential upside if they are hoping that they set earnings to a level where they are expecting to exceed these results.

The above is assuming that earnings will take a hit this year before rebounding some in prior years. For a long-term investor, we can often have the patience to wait out these periods of low or even negative growth in earnings.

Generally speaking, investing in a packaged food company, as history would suggest, means you are investing in a more conservative area of the market. You aren’t looking to make doubles or triples here but invest in a company that can be around for decades, pumping out steady dividends.

One thing that was able to boost revenue during the high inflation period previously was significant price increases. However, price/mix was now showing a decline in the latest quarter, with volume also taking a hit.

Looking at fiscal 2023 for some context, the company was able to grow net sales by 2.2%, but that came from a 9.9% improvement in price/mix. That was more than enough to offset the 7.7% volume decline.

Here is a look at the bridge chart for Q2 FY 2024 year-over-year.

That said, as indicated by the FY 2023 figures, the pace of volume declines is much more muted and trending in the right direction.

Bright spots in the report were in the international and food service segments of the business. Unfortunately, those are the two smallest business segments by a meaningful margin. Based on this latest quarter, they saw a combined ~18% share of total net sales.

Still, the better volume and price/mix of international and net positive volume and price/mix of food service divisions did help dampen some of the blow. In fact, the strong price/mix of these two segments did a lot to mute the company’s overall price/mix.

In their largest divisions, it seems it’s simply taking consumers longer to adjust. We are all faced with significantly higher grocery prices even as inflation has cooled in terms of the cost of goods for these companies.

Yes, COGS inflation continues to remain sticky, but the pace is down significantly here as well. Q4 2023 showed COGS at 5.4%, and now that’s been moderated to 1.7%. Productivity efforts contributed 1% to adjusted operating margins, which helped to offset a good portion of the COGS impact as well.

In terms of their leverage, they have continued to expect the net leverage ratio to hit 3x by the end of FY 2026, with the latest coming in at 3.55x. That was down year-over-year from the 3.9x ratio. However, that was up from the Q1 net leverage ratio of 3.4x. Despite that, they noted that they were able to pay down more than $500 million in the last 12 months.

Our strong free cash flow has helped us deliver debt reduction during the period. At the end of Q2, our net leverage ratio was 3.55 times, reflecting debt repayment of more than $500 million over the last 12 months. Looking ahead to the remainder of fiscal ’24, we expect to continue our debt reduction efforts as we prioritize our long-term leverage target of 3 times.

Steadily Growing Dividend

In looking at the dividend for CAG, they’ve been able to deliver some steady growth over the years. That growth picked up substantially in the last several years as well. With a dividend yield of nearly 5%, there is definitely appeal here for income investors.

Not only is a high yield enticing but, of course, the coverage of the dividend is paramount.

On the coverage front, we are seeing strong coverage of the dividend. Thanks to the same free cash flow (“FCF”) that they’ve been able to utilize to pay down their debt, we also get strong FCF coverage of the dividend. They posted $641 million in FCF for the first half of FY 2024, up from the $109 million from the same period a year ago.

Shares outstanding are just over 478 million, translating into roughly $1.34 FCF per share in the first half of the year. Put that against the quarterly dividend of $0.35, multiply by 2, and you arrive at a FCF payout ratio of around 52%. This is similar to the adjusted EPS payout ratio looking forward; assuming the $2.60 in earnings, we’d arrive at a payout ratio of under 54% against the $1.40 annualized dividend.

The significant FCF allows them plenty of cushion to continue to work on their leverage, deliver a dividend, even continue to grow the dividend if they choose, and provide some capital for growth initiatives as well.

Conclusion

CAG reported mixed results, with revenue that came in just shy of analyst expectations. Along with that, there was worse news as guidance was shaved lower. This was after Q2 2024 results saw weaker results nearly across the entire board in terms of financial metrics. That said, CAG is not priced for perfection with overly optimistic expectations. Fortunately, that meant a relatively muted response in terms of the share price. Additionally, it still makes CAG an interesting value choice today for dividend investors.